in 


^Reprinted  from  The  Annals  of  the  American  Academy  of  Political  and  Social 

Science,  Philadelphia,  January,  1916.  , 


^ 


Publication  No.  972. 


RECENT  FINANCIAL  INVESTIGATIONS  BY  THE  INTER- 
STATE  COMMERCE  COMMISSION 

By  Ernest  Ritson  Dewsnup, 
Professor  of  Railway  Administration,  University  of  Illinois. 

The  act  to  regulate  commerce  gave  to  the  commission,  created 
by  it,  authority  to  inquire  into  the  management  of  the  business  of 
interstate  common  carriers.  No  limitation  upon  the  scope  of  in- 
quiry so  long  as  it  concerned  the  management  of  the  business  of 
carriers  subject  to  the  act  would  appear  to  have  been  imposed. 
Under  this  authority,  the  Interstate  Commerce  Commission  has 
apparently  had  power,  at  any  time  during  its  existence,  to  investi- 
gate not  merely  rates  and  traffic  regulations  but  also  any  matters 
concerning  operation  and  fiscal  administration  that  it  chose  to  be 
interested  in.  However,  this  large  investigative  power  was  allowed 
to  lie  more  or  less  in  abeyance,  so  far  as  the  last  mentioned  aspects 
of  railway  management  were  concerned,  for  twenty-five  years  or 
thereabouts.  To  some  extent,  it  was  incapable  of  effective  utili- 
zation on  account  of  the  failure  of  the  original  act  to  provide  suffi- 
ciently complete  control  over  traffic  and  fiscal  records  and  accounts 
or  adequate  machinery  with  which  to  pursue  inquiries  of  this  kind. 
The  Hepburn  amendment  of  1906  remedied  this  by  definitely 
,  assigning  to  the  commission  such  control  and  bj'-  authorizing  the 
.employment  of  special  agents  or  examiners  with  full  powers  of  in- 
vestigation. 

The  half-dozen  years  immediately  following  the  enactment  of 
I  the  Hepburn  amendment  were  employed  by  the  commission  in 
'molding  into  uniform  pattern  the  myriad-shaped  accounts  of  the 
"T^carriers  and  in  organizing  a  corps  of  inspection  to  assist  in  this  de- 
T^sirable  simplification.  By  1912,  the  commission  evidently  felt  itself 
tin  a  position  to  make  use  of  its  strengthened  facilities  of  inquiry, 
)and,  with  admirable  courage,  determined  to  try  its  hand  upon  no 
jless  important  a  corporate  body  than  that  of  the  New  York,  New 
Haven  and  Hartford  Railroad  Company,  including  its  ancillary 
'  member,  the  Boston  and  Maine  Railroad. 

For  some  time  prior  to  the  investigation  undertaken  by  the 

1 


? 


^y^^^oO 


2  The  Annals  of  the  American  Academy 

coniiiiission  in  1012,  there  luul  been  severe  criticism  of  the  operating 
and  tinancial  methods  of  the  Xew  Haven  system.  The  investiga- 
tion, into  which  the  commission  entered  as  the  result  of  an  informal 
inquiry  by  one  of  its  special  agents,  turned  out  to  be  a  most  exten- 
sive one,  the  hearings  consuming  thirty-seven  days  and  resulting 
in  over  six  thousand  pages  of  type-written  testimonj\  The  report 
of  the  commission  published  in  the  stimmer  of  1913^  stirred  the 
interest  of  Congress,  and,  in  the  following  February,  the  Senate 
passed  a  resolution  instructing  the  commission  to  re-open  the 
examination  of  the  affairs  of  the  company  and  to  make  further 
investigation  of  its  financial  transactions.  In  accordance  with  these 
instructions,  a  still  more  intensive  examination  was  undertaken, 
in  the  course  of  which  nearly  fortj''  persons  were  placed  upon  the 
stand — their  testimony  and  the  exhibits  in  connection  with  the  case 
requiring  two  thick  volumes  for  their  printed  presentation.' 

Very  soon  after  the  election  of  Mr.  C.  S.  Mellen  to  the  presi- 
dency of  the  New  Haven  road,'  that  company  proceeded  to  extend 
its  control  of  trolley  lines  in  southern  Xew  England  by  bold  and 
hazardous  steps.  To  this  end  it  organized  the  Providence  Securi- 
ties Company  which  exchanged  its  4  per  cent  debentures,  guaran- 
teed by  the  New  Haven  road,  for  the  whole  of  the  securities  of  the 
Rhode  Island  Securities  Company,  a  company  which  the  United 
Gas  Improvement  Company  of  Philadelphia  had  organized,  in 
July,  1902,  to  hold  the  capital  stock  of  the  Rhode  Island  Company, 
the  last  named  being  the  operating  company  (organized  in  June, 
1902)  controlling,  under  999-year  leases,  about  two  hundred  and 
forty  miles  of  trolley  lines  in  Rhode  Island.  The  cash  investment 
of  the  last  named  company  appears  to  have  been  but  little  over 
nine  and  one-half  million  dollars  but,  in  its  determination  to  secure 
a  monopolistic  grip  of  the  trolley  situation,  the  New  Haven  spent  in 
money  and  securities  over  twenty-four  million  dollars,  an  astounding 
expenditure  in  view  of  the  fact  that  from  the  organization  of  the 
Rhode  Island  Company  until  its  purchase  in  1906,  it  had  failed  to 
pay  a  dividend;  indeed,  its  income  account  showed  a  surplus  of  but 

1  27  iTilerslate  Commerce  Commission  Reports,  pp.  560-617.  The  New  England 
Investigation. 

*  63d  Congress,  2d  session,  1913-14.     Senate  Documents,  vols.  19  and  SO. 

*  November,  1903.  Mr.  Mellen  had  been  president  of  the  Northern  Pacific 
Railway  Company  from  1897,  and  previously,  for  several  years,  vice-president  of 
the  New  Uaven  road. 


Investigation  by  Interstate  Commerce  Commission       3 

$397,000  up  to  June  30,  1908.  It  was  part  of  the  agreement  with 
the  United  Gas  Improvement  Company  that  the  New  Haven  should 
also  take  over  the  Connecticut  trolley  lines,  and  here  again  a  sum 
was  paid  considerably  in  excess  of  their  value — $10,000,000,  accord- 
ing to  former  president  Mellen's  testimony. 

That  the  New  Haven  management  was  prepared  to  make  the 
most  extravagant  expenditures  in  its  endeavor  to  suppress  com- 
petition is  further  illustrated  in  its  acquisition  of  the  New  York, 
Westchester  and  Boston  Railway  Company,  a  property  which 
ultimately  cost  it  nearly  thirty-six  and  one-half  million  dollars 
for  a  line  of  eighteen  miles  in  length.*  The  acquisition  was  under- 
taken by  a  special  committee  with  power  to  act,  composed  of  J.  P. 
Morgan,  William  Rockefeller  and  G.  M.  Miller,  with  President 
Mellen  ex-officio.  This  committee  was  appointed  by  the  standing 
committee  of  the  Board  of  Directors  after  Mr.  Mellen  had  made  a 
statement  concerning  the  "proposed  competition  between  the  Con- 
necticut State  line  and  the  Harlem  River."  Five  days  later 
(September  22,  1906),  this  action  was  approved  at  a  regular  meet- 
ing of  the  full  Board,  fifteen  of  the  directors  being  present.  The 
report  of  the  Interstate  Commerce  Commission  ^  states  that  the 
full  Board  was  not  taken  into  the  confidence  of  those  directors  who 
wanted  the  Westchester  securities  purchased.  However,  the 
testimony  seems  to  indicate  that,  in  appointing  this  committee  in 
such  general  terms,  the  directors  were  aware  of  the  purpose  of  their 
vote,  though  not  anticipating  so  heavy  a  purchase  price  as  was 
actually  paid.  ^ 

Some  thirteen  months  later,  the  Morgan-Rockefeller  com- 
mittee reported  to  the  Board  that  it  had  secured  control  of  the 
properties  at  a  cost  of  more  than  eleven  million  dollars.  For  this 
large  expenditure,  the  New  Haven  became  the  possessor  of  two 
"beclouded"  franchises  for  lines  parallel  and  in  close  proximity  to 
its  own  tracks.     The  tangible  assets  underlying  the  Westchester 

^  The  line  extends  from  174th  St.,  New  York  City,  a  distance  of  6.83  miles  to 
Mount  Vernon  (fom-  tracks),  thence  bifurcating  into  two  double  track  lines,  one 
to  New  RocheUe  (2.16  miles)  and  the  other  to  White  Plains  (9.04  miles).  A  per- 
petual lease  gives  also  the  use  of  the  3.72  miles  of  track  between  174th  St.  and  the 
Harlem  River  over  the  tracks  of  the  Harlem  River  and  Port  Chester  RaUroad. 

*  SI  Interstate  Commerce  Commission  Reports,  pp.  32-132. 

^  See  63d  Congress,  2d  session.  Senate  Documents,  Vol.  19,  p.  1015,  Testi- 
mony of  [Director]  WiUiam  Skinner. 


4  The  Annals  of  tue  American  Academy 

and  Port  Chester  coiiipanies  and  the  City  and  County  Contract 
Company  (the  construction  company),  at  the  time  of  the  acquisi- 
tion of  the  property  by  the  New  Haven,  would  seem  to  have  been 
about  four  miUion  one  hundred  and  sixty  thousand  dollars.  Both 
franchises  were  being  attacked  in  the  courts  and  an  application 
for  permission  to  consolidate  the  two  projects  and  construct  but 
one  road  was  held  up  by  court  injunction.  To  straighten  out  the 
legal  tangle  and  to  secure  the  necessary  amendments  to  the  fran- 
chises, President  Mellen,  with  the  aid  of  the  late  Thomas  J.  Byrnes, 
sometime  inspector  in  the  New  York  pohce  force,  expended  an  ad- 
ditional 81,500,000,  the  trail  of  this  expenditure  being  hidden  bj' 
the  transfer  of  New  Haven  securities  to  its  subsidiary  company, 
the  New  England  Navigation  Company,  which  thereupon  trans- 
ferred them  to  its  President,  who  happened  to  be  the  same  C.  S, 
Mellen  that  presided  over  the  parent  company.  The  outlay  of  this 
money  secured  for  the  New  Haven  road  the  control  of  30,431  of 
the  34,053^  Westchester  shares  still  outstanding,  worth,  as  Mr. 
Mellen  cj'uically  testified  later,  about  ten  cents  a  pound.  The 
Interstate  Commerce  Commission,  in  its  report,  had  no  hesitation 
in  charging  a  corrupt  purpose  in  the  manipulation  of  this  expen- 
diture. In  addition  to  the  above  payments,  a  further  Sl,400,000 
was  paid  out  in  settlement  of  the  claims  of  parties  in  control  of  the 
Port  Chester  Company,  and  of  the  damages  accruing  to  Thorne 
and  Perry  (who  had  been  acting  as  agents  for  the  New  Haven  in 
securing  the  property)  on  account  of  the  rescission  of  their  contract. 
In  the  course  of  the  investigation  by  the  Commission,  it  seems  that 
Thorne  and  Perry  failed  to  account  for  81,032,000  of  the  moneys 
expended  by  them. 

Thus  it  appears  that  the  Morgan-Rockefeller  committee  of  the 
New  Haven  Board  was  responsible  for  disbursing  over  fourteen 
million  dollars  for  tangible  assets,  as  already  stated,  of  a  little  over 
four  millions.  To  complete  the  construction  of  the  road,  822,000,- 
000  was  required,  thus  making  836,000,000  in  all,  the  fixed  charges 
involving  a  payment  of  81,250,000  per  annum  beyond  the  earnings, 
and  according  to  the  testimony  of  the  President  of  the  road,  the 
earnings  at  the  time  of  the  investigation  were  less  than  25  per  cent 
of  the  amount  necessary  to  make  the  property  self-sustaining. 
Such  finance  savors  of  monopoly  mania.  That  such  eminent 
financiers  should  have  been  responsible  for  it  makes  the  matter  only 


Investigations  by  Interstate  Commerce  Commission      5 

the  more  astounding.  To  judge  from  Mellen's  testimony,  the  rela- 
tion of  the  highly  paid  President  of  a  most  important  railway  com- 
pany to  the  late  J.  P.  Morgan  resembled  nothing  more  closely  than 
that  of  the  office  boy  to  his  "boss."  The  evidence  does  not  reveal 
the  underlying  purpose  of  Mr.  Morgan  in  putting  this  deal  through 
and  it  might  be  said  that,  in  reply  to  a  direct  inquiry  from  the 
present  chairman  of  the  New  Haven,  the  firm  of  J.  P.  Morgan  and 
Company  asserted  that  in  the  course  of  the  twenty  years  prior  to 
December  4,  1913,  they  realized  a  total  net  profit  of  not  more  than 
approximately  $350,000.  from  the  handling  of  the  securities  of  the 
New  Haven  and  its  subsidiary  companies.'' 

The  Billard  transactions  afford  another  example  of  the  New 
Haven's  financial  extravagance,  as  also  of  its  defiance  of  statutory 
regulation.     The  space  at  our  disposal  will  not  permit  us  to  enter 
into  detail,  but,  in  brief,  these  transactions  arose  out  of  a  decision 
of  the  Supreme  Court  of  Massachusetts  which  made  it  very  clear 
that  in  acquiring  a  substantially  controlling  interest  in  the  Boston 
and  Maine  Railroad,  in  1907,  the  New  Haven  had  acted  illegally. 
The  stock  had  been  acquired  in  the  name  of  the  New  Haven's 
subsidiary,  the  New  England  Navigation  Company.     Accordingly, 
the  New  Haven  proceeded   apparently  to    divest    itself    of    the 
property  by  having  the  Navigation  Company  sell  the  stock  to  a 
Mr.  John  L.  Billard.     However,  within  about  a  year  after  this  sale,A 
the  New  Haven  succeeded  in  securing  the  passage  of  a  bill  by  the  I 
legislature  of  Massachusetts  authorizing  the  incorporation  of  the  I    ,^\' 
Boston  Railroad   Holding  Company  with  power  to  acquire  and  I   v 
hold  a  majority  of  the  stock  of  the  Boston  and  Maine  Railroad/ 
(June  24,  1909).     Thereupon,  Billard  was  induced  to  sell  back  the' 
stock  to  the  Navigation  Company  which  transferred  it  to  the  new 
holding  company.     But  when  investigation  came  to  be  made,  it 
was  obvious  that  at  no  time  during  the  couple  of  years  covered  by 
these  transactions  had  the  New  Haven  really  relinquished  its  con- 
trol of  the  Boston  and  Maine.     Billard,  a  coal  merchant  of  Meriden, 
Conn.,  was  by  no  means  in  a  financial  condition  to  handle  such  a 
large  deal.     Actually  he  did  not  put  out  a  dollar  of  his  own  money. 
He  did  not  even  handle  the  shares.     The  $13,750,000  representing 
the  purchase  price  was  raised  by  an  advance  of  $11,000,000  by  the 
National  City  Bank  of  New  York,  on  the  stock  deposited  as  col- 

^  See  Railway  Age  Gazette,  March  13,  1914. 


G  The  Annals  of  the  American  Academy 

lateral,  and  the  balance  of  nearly  two  and  three  quarter  million 
dollars  was  then  taken  care  of  through  the  acceptance  by  the 
Navigation  Company  of  an  unsecured  note  of  Dillard's.  Neverthe- 
less, Billard  would  seem  to  have  pulled  $2,748,000  out  of  the  busi- 
ness, for  the  securities  were  sold  to  him  at  S125  and  bought  back  at 
$150  per  share,  and  this  despite  the  understanding  of  the  Board 
of  Directors  of  the  New  Haven  that  Billard  was  to  receive  only 
a  reasonable  compensation  for  the  service  he  performed. 
Billard,  by  the  way,  took  care  to  burn  his  books  and  papers,  pre- 
sumably to  avoid  embarrassment  from  any  examination  of  them. 

The  monopolistic  ambitions  of  the  New  Haven  management 
extended  not  only  to  control  of  electric  trollej's  and  suburban  and 
main  line  railroads,  but  also  to  that  of  water  communications. 
Adopting  its  usual  methods  of  "dummy  companies  and  dummy 
officers  and  directors,"  the  railroad  acquired  control  of  half  a  dozen 
of  the  leading  steamship  lines  of  New  England  at  a  total  cost  of 
nearly  twenty-five  million  dollars  for  property  with  a  physical 
valuation  of  about  ten  million  dollars. 

Space  will  not  permit  a  description  of  the  questionable  practices 
of  the  New  Haven  in  the  manipulation  of  its  accounts,  of  its  ad- 
vances to  subsidiary  companies  to  enable  them  to  pay  dividends 
which  in  turn  were  credited  to  the  former  road  in  its  income  account. 
The  commission  states  that 

the  accounts  of  the  company  are  replete  with  instances  in  which  proBts  have  been 
declared  to  be  earned  by  the  transfer  of  stocks,  bonds,  and  debentures,  and  securi- 
ties of  one  of  the  subordinate  and  subsidiary  companies  of  the  New  Haven  sys- 
tem, to  another  such  subsidiary,  and  such  profits  are  solemnly  recorded  as  real 
profits  in  working  up  the  accounts  of  the  system  as  a  whole.* 

Purchases  of  supplies  to  large  amounts  were  made  without  bids, 
and  frequently  from  companies  having  men  as  directors  who  were 
also  on  the  Board  of  the  New  Haven.  Lavish  contributions  to 
both  political  parties  were  made,  large  sums  were  expended  to 
"educate"  public  opinion;  one  well  known  professor  of  law  in  New 
England  was  paid  .S1(),000  a  year,  besides  payments  to  his  brother  * 

and  father  of  .?25  and  -SoO  a  day. 

The  commission  estimated  that  the  loss  to  the  New  Haven 
Company  through  waste  and  mismanagement,  amounted  to  be- 
tween S60,000,000  and  §90,000,000,  the  burden  of  which  will  be  a 

•  SI  Interstate  Commerce  Commission  Reports,  p.  59. 


Investigations  by  Interstate  Commerce  Commission      7 

heavy  drain  for  many  years  upon  its  resources.  Undoubtedly,  the 
present  management,  under  the  very  capable  direction  of  Mr. 
Howard  Elliott,  in  whose  unimpeachable  honesty  the  pubHc  has 
every  confidence,  will  ultimately  be  able  to  restore  prosperity  to 
the  undertaking,  but  the  task  will  be  a  difficult  one.  The  new  ad- 
ministration, before  the  opening  of  the  investigation  ordered  by  the 
Senate,  had  already  entered  into  an  agreement  with  the  Attorney 
General  of  the  United  States  to  divorce  the  New  Haven  Company 
from  the  Boston  and  Maine,  the  trolley  lines,  and  most  of  the 
steamship  lines,  and  certain  other  steps  had  also  been  taken  to 
free  the  company  from  the  responsibility  of  those  subsidiary  com- 
panies whose  association  with  it  had  been  criticized.^ 

Just  about  the  time  that  the  first  New  Haven  investigation 
was  drawing  to  a  close,  and  before  the  commission  had  issued  its 
report  thereupon,  one  of  the  well-known  western  railways,  the  St. 
Louis  and  San  Francisco  Railroad  Company,  along  with  its  sub- 
sidiary, the  Chicago  and  Eastern  Illinois  Railroad,  went  into  the 
hands  of  receivers.  The  receivership  caused  a  good  deal  of  com- 
ment and  finally  led  to  resolutions  by  the  United  States  Senate,  in 
the  following  June  and  July,  instructing  the  commission  to  report 
to  that  body  all  the  facts  connected  with  the  purchase  of  the 
Chicago  and  Eastern  Illinois  Railroad,  and  the  St.  Louis,  Browns- 
ville and  Mexico  Railroad  by  the  Frisco  company,  and  also  with  the 
subsequent  receiverships.  The  testimony  secured  for  this  report  ^° 
evidenced  a  policy  on  the  part  of  the  Frisco  nianagement  that  was 
marked  by  a  high  degree  of  financial  recklessness.  It  seems  that, 
between  1897  and  1907,  the  Frisco  undertook  an  extensive  pro- 
gram of  acquisition  of  new  lines,  constructed  by  sjmdicates  with  the 
probable  understanding  that  the  former  would  purchase  them  after 
completion.  There  is  some  evidence  to  show  that  the  prices  paid 
for  these  properties  netted  large  profits  to  the  subscribers.  Officials 
of  the  Frisco,  including  the  chairman  of  the  Board  of  Directors, 
seem  to  have  participated  freely  in  these  dealings.  A  somewhat 
spectacular  example  of  Frisco  financing  occurred  in  the  case  of  the 
South  Texas  lines.     In  its  endeavor  to  secure  a  through  coast  route 

'  A  full  statement  of  the  action  taken  by  the  new  management,  and  of  the 
terms  of  the  agreement  with  the  Department  of  Justice  will  be  found  in  the 
Railway  Age  Gazette,  April  17,  1914. 

^°  29  Interstate  Commerce  Commission  Reports,  pp.  139-211. 


8  The  Annals  of  the  American  Academy 

between  Brownsville,  Texas,  and  New  Orleans — a  rather  remote 
traffic  interest — the  company  advanced  §33,000,000  for  the  con- 
struction of  lines  and  the  acquisition  of  control  of  existing  com- 
panies. The  loss  to  the  Frisco  on  these  transactions,  including 
discounts,  commissions  and  an  unliquidated  sum  of  S5,000,000  due 
to  it  by  the  New  Orleans  Texas,  and  Mexico  Railroad,  amounted 
to  more  than  eight  million  dollars.  Neither  the  Brownsville  line, 
nor  the  New  Orleans,  Texas  and  Mexico  has  met  its  fixed  charges 
since  1910. 

Prior  to  this,  the  Frisco  had  heavily  involved  its  credit  in 
gaining  control  of  the  Chicago  and  Eastern  Illinois  Railroad.  The 
basis  upon  which  the  latter  railroad  was  acquired  in  1902  made  it 
essential  that  the  Frisco  should  receive  regularly  dividends  of  6 
per  cent  on  the  preferred  stock  and  10  per  cent  upon  the  common 
stock  of  the  Chicago  and  Eastern  Illinois,  in  order  to  pay  the  inter- 
est charges  on  the  stock  trust  certificates  with  which  it  had  obtained 
the  securities  of  that  company.  Actually,  the  dividends  paid  by 
the  common  stock  were  insufficient  to  meet  the  interest  charges, 
and,  to  May,  1913,  the  Frisco  had  suffered  a  loss  thereupon  of  over 
two  million  dollars  or,  deducting  the  interest  on  the  stock  certifi- 
cates owned  by  it,  a  net  loss  of  SI, 710,000.  After  December,  1011, 
the  subsidiary  road  ceased  to  pay  any  dividends  at  all.  The  price 
paid  by  the  Frisco  to  secure  this  line  of  entry  into  Chicago  seems  to 
have  been  an  extravagant  one  when  comparison  is  made  with  the 
dividend  earning  power  of  the  Chicago  and  Eastern  Illinois  prior  to 
the  acquisition. 

An  optimistic  view  of  the  effect  of  the  Frisco  alliance  upon  the 
earnings  of  the  Chicago  and  Eastern  Illinois  was  responsible,  per- 
haps, for  the  cheerfulness  with  which  the  Frisco  undertook  the 
financial  responsibility.  Indeed,  there  was  a  notable  increase  in 
the  gross  operating  revenue  of  that  road  from  S6, 000, 000  in  1901 
to  $15,000,000  in  1912.  But  the  management  was  not  successful  in' 
achieving  economy;  the  operating  expenses  increased  with  striking 
rapidity  (fourfold),  and  the  operating  ratio  rose  from  54.75  to  over 
80  per  cent.  The  increased  cost  of  materials  and  labor  does  not 
constitute  a  sufficient  explanation  of  such  an  increase. 

In  assigning  causes  for  the  Frisco  insolvency,  the  commission 
laid  emphasis  upon  the  disproportionate  amount  of  funded  in- 
debtedness, the  acquisition  of  new  lines,  the  financing  of  the  South 


Investigations  by  Interstate  Commerce  Commission      9 

Texas  lines,  the  Chicago  and  Eastern  Ihinois  deal,  sale  of  securities 
at  low  prices,  payment  of  unearned  dividends  on  preferred  stock, 
investment  in  stocks  of  non-dividend-paying  industrial  companies, 
and  payment  of  excessive  charges  upon  the  investment  in  and  use 
of  terminal  and  coal  properties. 

Less  than  two  months  after  the  report  upon  the  Frisco  situation, 
the  financial  methods  of  the  management  of  one  of  the  great  and 
supposedly  carefully  administered  railway  properties  of  the  middle 
west  were  brought  to  the  attention  of  the  public  in  the  report  of 
the  commission  upon  the  Chicago,  Milwaukee  and  St.  Paul  Railway 
Company." 

To  bolster  up  the  income  of  the  St.  Paul  road  for  1910,  the  in- 
come account  of  that  year  was  made  to  include  all  the  interest,  rents 
and  revenues,  over  four  million  six  hundred  thousand  dollars,  arising 
out  of  the  construction  of  the  Puget  Sound  road  in  previous  years. 
At  the  same  time,  operating  expenses  were  given  an  artificial  de- 
crease of  more  than  five  hundred  thousand  dollars  by  crediting  to 
the  current  year  the  salvage  of  cars  destroyed  previous  to  July  1, 
1909.  Since  they  had  not  been  taken  care  of  previously,  these  items 
should  have  been  handled  through  the  profit  and  loss  account.  After 
the  Puget  Sound  road  had  been  opened,  construction  of  branch  lines, 
etc.,  still  continued  to  be  active,  and,  according  to  the  accusation  of 
the  commission,  large  amounts  that  should  have  been  charged  as 
expenses  of  operation  were  entered  under  the  head  of  cost  of  con- 
struction. Furthermore,  notwithstanding  the  requirement  of  the 
commission,  laid  down  in  the  classification  of  operating  expenses 
issued  in  1907,  that  depreciation  should  be  annually  charged  on 
equipment,  the  accounts  of  the  company  failed  to  show  any  such 
provision.  These  accusations  constitute  a  lamentable  indictment 
against  the  St.  Paul  of  endeavoring  to  deceive  its  stockholders  and 
the  investing  pubUc  as  to  the  true  financial  status  of  the  company. 
By  the  artifices  above  mentioned,  the  Puget  Sound  road  was  enabled 
to  contribute  a  2  per  cent  dividend  towards  the  St.  Paul's  dividend 
of  1911,  thus  enabling  the  latter  company  to  make  a  fictitious  show- 
ing of  a  dividend  earned  entirely  out  of  current  income. 

The  overstatement  of  income  for  the  year  1909-10  led  to  a 
book  decrease  in  revenue  and  income,  during  the  following  year,  of 
more  than  two  million  dollars,  which  the  company's  report  explained 

"  29  Interstate  Commerce  Commission  Reports,  p.  508. 


10  The  Animals  of  the  American  Academy 

as  due  to  its  inabilit}-  to  obtain  increased  rates,  and  the  great  in- 
crease in  the  cost  of  labor.  Actually,  the  wage  bill  of  the  St.  Paul 
for  1910-11  was  nearly  fifty-six  thousand  dollars  less  than  that  for 
1909-10. 

The  balance  sheet  of  the  Puget  Sound  road  was  also  distorted 
to  the  extent  of  showing  a  property  investment  of  S100,000,000 
greater  than  was  actually  the  case.  As  explained  by  the  president 
of  the  St.  Paul,  the  directors  of  that  company  were  unable  to 
accept  the  stock  of  the  Puget  Sound  road  as  the  binding  security 
for  the  advances  made  to  the  latter,  and  so  they  had  that  company 
issue  first  mortgage  bonds  approximating  in  amount  the  S200, 000,000 
of  constructional  cost.  But  the  law  of  the  state  of  Washington,  under 
which  the  Puget  Sound  road  was  incorporated,  forbade  the  issue  of 
funded  debt  beyond  twice  the  amount  of  capital  stock.  To  meet 
this  requirement,  this  company  had  to  issue  to  the  St.  Paul  an  ad- 
ditional 8100,000,000  of  stock,  which  was  carried  on  the  books  of 
the  parent  company  at  merely  a  nominal  value.  The  explanation, 
though  it  makes  clear  that  in  this  matter  there  was  no  intent  to 
deceive,  was  a  very  lame  and  unsatisfactory  one.  An  accounting 
could  have  been  made  in  accordance  with  the  commission's  regula- 
tions that  would  have  shown,  on  the  Puget  Sound  balance  sheet, 
a  discount  on  securities  sold  of  the  8100,000,000  of  stocks  issued 
less  the  nominal  amount  for  which  this  was  carried  on  the  St.  Paul 
balance  sheet,  the  item  being  entered  under  deferred  assets;  or  an 
explanatory  note  could  have  been  attached  to  the  balance  sheet 
explaining  the  reason  for  the  irregularity. 

The  most  recent  of  the  financial  investigations  of  the  Interstate 
Commerce  Commission  has  been  that  into  the  condition  of  the 
Chicago,  Rock  Island  and  Pacific  Railway  Company,  the  final 
hearings  in  connection  with  which  were  held  last  June.*^  The 
acquisition  of  the  control  of  the  Rock  Island  in  1901  by  Reid,  Leeds 
and  the  two  Moores,  the  subsequent  organization  of  the  two  hold- 
ing companies,  the  Chicago,  Rock  Island  and  Pacific  Railroad 
Company  of  Iowa,  and  the  Rock  Island  Companj^  of  New  Jersey, 
with  a  capitalization  of  8200,000,000  for  the  former  and  of  8150,- 
000,000  for  the  latter,  the  concentration  of  control  in  the  preferred 
stock  of  the  New  Jersey  corporation,  all  these  matters  are  famihar 
to  the  reader  and  need  not  be  rehearsed  here,  but  there  are  certain 

"  36  Interstate  Commerce  Commission  Reports,  pp.  43-61. 


Investigations  by  Interstate  Commerce  Commission     11 

less  familiar  facts  that  deserve  attention  here  since  they  throw  a 
lurid  light  upon  the  possibilities  of  financial  manipulation  by  such 
men  as  those  already  named. 

Apparently,  the  rights  of  the  stockholders  in  the  earnings  of 
thd  company  were  deemed  of  little  account.  Salaries  shown  on  the 
payroll  were  supplemented  by  secret  allowances  and  bonuses. 
Presents  of  considerable  sums  were  made  to  both  officers  and  mem- 
bers of  the  Board  of  Directors.  About  a  million  dollars  was  dis- 
tributed to  officials  of  the  railwaj^  company  in  excess  of  their 
salaries.  Irregular  payments  were  made  for  "  supporting  the  market, 
while  the  bonds  of  the  railway  company  were  being  sold,"  for  con- 
tributions to  campaign  committees,  for  rebates  to  a  Denver  news- 
paper, for  securing  discontinuance  of  a  line  of  road  being 
constructed  between  Peoria,  Illinois,  and  Clinton,  Iowa. 

Misrepresentation  of  assets  was  made  unblushingly.  As  late 
as  June,  1914,  the  railway  company  carried  an  amount  of  nearly 
six  million,  two  hundred  thousand  dollars  as  surplus,  based  upon: 
(1)  a  book  value  of  nearly  three  and  three-quarter  million  dollars 
ascribed  to  the  securities  of  the  Trinity  and  Brazos  Valley  Railway, 
a  company  then  in  the  hands  of  receivers;  (2)  a  book  value  of 
$6,000,000  of  Clover  Leaf  bonds,  secured  only  by  Chicago  and  Alton 
Railroad  stock  having  a  current  market  value  of  little  more  than 
one  and  one  half  miUion  dollars;  (3)  a  book  value  of  $200,000  of  the 
stock  of  a  Nebraska  railway  company  and  a  construction  company 
that  had  no  existence  except  on  paper;  (4)  a  book  value  of  nearly 
six  million  dollars  attributed  to  the  worthless  five  per  cent  debenture 
bonds  of  the  Iowa  holding  company.  As  pointed  out  by  the  com- 
mission, a  proper  valuation  of  assets  would  have  changed  the  so- 
called  surplus  into  a  deficit  of  nearly  twelve  million  dollars. 

In  general,  financing  operations  of  the  Rock  Island  management 
seem  to  have  been  distinguished  by  anything  but  business  acumen. 
When  the  fear  of  action  under  the  Sherman  law  caused  the  divorce 
of  the  combined  Rock  Island-Frisco  interests,  the  sum  realized  by 
the  sale  of  the  Frisco  stock,  which  had  been  deposited  as  collateral 
for  the  bonds  of  the  Iowa  company,  was  insufficient  to  redeem  the 
latter,  but  the  Iowa  compan}^,  with  no  resources  of  its  own,  issued 
seven  and  one-half  million  dollars  worth  of  bonds  to  the  Chicago, 
Rock  Island  and  Pacific  Railway,  almost  at  par,  the  latter  raising 
the  'cash  by  a  bank  loan.     One  million,  three  hundred  and  eighty- 


12  The  Annals  of  the  American  Academy 

eight  thousand  dollars'  worth  of  these  bonds  was  retired  later,  but  the 
remaining  ?6, 112,000  was  unable  to  be  retired  bj'-  the  Iowa  company 
as  it  had  no  assets.  The  Rock  Island's  investments  in  the  stock  of 
the  Chicago  and  Alton  Railroad  ended  in  a  loss  of  over  six  million 
dollars.''  Its  agreement  with  the  Colorado  and  Southern  for  the 
financing  of  the  Trinity  and  Brazos  Valley  Railway  also  ended  unfor- 
tunately. Advances  of  nearly  three  and  three-quarter  million 
dollars  were  made,  upon  which  unpaid  interest  had  accrued,  to 
June  30,1914,  of  another  three-quarter  million  dollars — in  a  property 
whose  annual  income  accounts  have  been  replete  with  deficits  and 
which  finally  went  into  the  hands  of  a  receiver. 

The  incorporation  of  the  Consolidated  Indiana  Coal  Company', 
in  April,  1905,  was  made  the  occasion  for  paying,  out  of  the  treas- 
ury of  the  railwaj'  company  to  the  general  counsel  of  the  latter,  a 
S30,000  a  year  official,  the  sum  of  810,000  for  drawing  up  the  in- 
corporation papers.  The  railway  guaranteed  the  coal  company's 
bonds,  and  in  consideration  thereof  received  82,400,000  (out  of 
$3,400,000)  capital  stock.  To  June  30,  1914,  the  railway  company 
had  advanced  82,354,000  to  the  coal  company,  and,  since  1910, 
unpaid  interest  has  amounted  to  more  than  four  hundred  thousand 
dollars  additional. 

Other  curious  transactions  might  be  mentioned,  as,  for  instance, 
that  in  which  the  railway  company  sold  bonds  of  the  Rock  Island 
Improvement  Company  (a  subsidiary  of  the  holding  companies 
organized  to  acquire  transportation  equipment  and  facilities  for  the 
railway  company)  at  less  than  par,  only  to  buy  them  back  at  more 
than  par  some  six  months  later. 

The  ultimate  result  of  the  Reid-AIoore  syndicate  was  to  throw 
the  railway  into  a  receivership.  Here  again,  apparently,  the  sinis- 
ter nature  of  the  syndicate's  policy  is  perceptible.  It  seems  pretty 
clear  that  the  railwaj'  could  have  arranged  to  meet  all  its  pressing 
obligations,  in  spite  of  the  growing  unsatisfactoriness  of  its  financial 
condition,  but  the  syndicate  wanted  a  receivership,  presumably  for 
purposes  of  its  own,  and,  without  the  knowledge  of  and  regardless 

"  It  has  been  suggested  that  the  object  of  the  Reid-Moore  syndicate  in 
purchasing  the  Frisco  was  to  avoid  duplication  of  new  railroad  building,  and  that 
the  investment  in  the  Chicago  and  Alton  was  with  the  idea  of  securing  a  better 
line  east  of  Kansas  City  than  the  admittedly  unsatisfactory  hne  of  the  Rock 
Island.  But  if  these  were  the  objects  of  the  transactions,  they  neverthelesa 
ended  in  disastrous  failure. 


Investigations  by  Interstate  Commerce  Commission     13 

of  the  interests  of  the  stockholders,  and  without  acquainting  the 
representative  of  the  minoritj^  stockholders  on  the  Board  of  Directors 
of  its  intention,  made  application  to  the  court.  The  bill  for  re- 
ceivership seems  to  have  been  completed  by  the  general  counsel  of 
the  company  on  March  29;  though  this  fact  was  known  only  to  a 
select  few.  It  is  worthy  of  notice  that,  between  that  date  and  the 
date  of  fiUng,  April  20,  the  stock  of  the  railway  company  began  to 
be  largely  dealt  in  on  the  market.  The  suspiciousness  of  this  is 
undeniable  but  there  is  no  absolutely  conclusive  evidence  that  the 
Reid-]\Ioore  people  helped  to  create  the  artificial  price  that  was 
reached  on  the  Exchange.  The  editor  of  the  Railway  Age  Gazette 
expresses  his  opinion,  which,  though  not  conclusive,  is  worthy  of 
respect,  that  this  whole  stock  movement  looked  "far  more  like  an 
attempt  of  a  clique  of  comparatively  small  speculators  to  put  up 
the  price  than  any  attempt  on  the  part  of  the  controlling  interests 
to  make  a  market  on  which  they  could  unload  their  holdings."  ^* 
However  this  may  be,  a  more  reprehensible  example  of  financial 
jugglery,  incompetence  and  heartless  disregard  of  the  interests  of 
investors  than  that  of  the  Reid-Moore  administration  would  be 
hard  to  find.  The  syndicate  took  hold  of  a  property  whose  shares 
were  valued  at  S175  and  upwards  on  the  market;  by  the  time  their 
manipulations  were  completed,  the  shares  were  selling  at  a  mere 
ninth  or  tenth  of  that  value,  and  for  no  small  part  of  that  decrease 
the  syndicate  must  be  held  responsible. 

The  above  recital  of  the  facts  disclosed  by  the  inquiries  of  the 
Interstate  Commerce  Commission  speaks  for  itself.  Disillusion- 
ment must  surely  have  come  to  many  who  have  had  unquestioning 
confidence  in  the  supreme  ability  and  unerring  foresight  of  our  states- 
men of  private  finance.  There  has  been  too  great  a  tendency  in 
financial  circles  to  place  the  responsibility  that  legally  accrues  to 
each  individual  taking  part  in  the  management  of  industrial  enter- 
1  prises  upon  the  shoulders  of  ambitious  colleagues.     Of  course,  the 

individual  of  unusual  abilit}''  will  always  be  able,  and  it  is  desirable 
that  he  should  be  able,  to  exercise  a  powerful  influence  upon  the 
management.  But  this  should  not  and  must  not  be  allowed  to 
justifj^  improper  and  dangerous  concentration  of  power  through  the 
neglect  of  directors  to  direct. 

Our  present  type  of  railway  directorate,  and  no  doubt  this 

^*  Railway  Age  Gazette.     June  11,  1915,  p.  1228. 


? 


$ 


14  The  Annals  of  the  American  Academy 

applies  to  other  fields  of  industrial  administration,  needs  reorganiza- 
tion. The  example  set  by  the  government  in  its  prosecution  of 
eleven  directors  of  the  former  New  Haven  regime  will  have  a  salutary 
influence  in  this  direction.  Every  effort  should  be  made  to  hold 
directors  to  a  strict  accounting  for  maladministration  of  property 
committed  to  their  care.  Such  a  policy,  vigorously  pursued,  would 
undoubtedly  lessen  the  inclination  of  directors  to  treat  their  respon- 
sibilities as  merely  nominal.  There  would  be  fewer  instances  of 
plural  directors,  physicall}'  incapable  of  keeping  close  supervision 
over  the  managerial  policies  of  their  various  companies.  Railway 
companies  would  be  well  advised  to  restrict  the  number  of  directors 
upon  their  boards,  and  to  see  that  each  directorate  is  composed 
largely  of  men  in  close  touch  with  their  properties.  It  should  be 
made  obligatory  upon  every  interstate  common  carrier  to  place, 
after  the  name  of  each  director  in  the  annual  report  not  only  his  place 
of  residence  but  also  the  amount  of  his  bona-fide  stock  holdings  in  the 
compan}',  and  there  should  be  included  in  the  report  a  tabular  state- 
ment, based  upon  the  individual  affidavits  of  the  directors,  showing 
for  each  director  his  holdings  of  securities  in  other  common  carriers. 

Each  annual  report  of  interstate  common  carriers  should  be 
required  to  state  in  as  plain  a  form  as  practicable  not  only  the  nature 
and  amount  of  all  securities  disposed  of  during  the  current  fiscal 
year  but  also  the  nature  and  amount  of  expenditures  made  out  of 
the  resulting  funds.  In  the  case  of  properties  purchased  outright  or 
in  which  a  controlling  interest  has  been  acquired,  the  amount  paid  in 
cash  or  securities  or  in  both  should  be  specified  and  a  brief  descrip- 
tion given  of  the  property  acquired  and  of  the  purpose  of  acquisi- 
tion. Corresponding  information  should  be  furnished  in  the  case 
of  leases.  A  statement  of  all  guarantees  of  interest  or  dividend 
payments  assumed  should  be  given.  It  is  satisfactory  to  note  that 
a  good  deal  of  this  information  is  now  included  in  the  reports  of, 
at  any  rate,  the  larger  companies. 

To  facilitate  more  exact  assessment  of  the  standard  of  mainte- 
nance maintained  by  each  railway  administration,  there  should  be 
required  in  each  annual  report:  (1)  a  record  of  the  main  classes  of 
equipment,  with  the  average  age  of  each  class;  (2)  a  record  of  track 
conditions,  specifying  the  proportion  of  heav>'  and  light  rails, 
mileage  of  ballast  of  each  class,  subclassified  so  as  to  show  depth  of 
ballast,  number  of  treated  and  untreated  ties,  with  average  number 


Investigations  by  Interstate  Commerce  Commission     15 

of  years  already  in  track ;  (3)  a  structural  report  classifying  the  main 
structures  according  to  their  component  materials. 

The  above  measure  of  protection  to  investors  represents  as 
far  as  it  is  wise  to  proceed  at  the  present,  probably,  for,  despite  the 
powers  enjoj^ed  by  the  commissions  of  certain  states,  it  is  doubtful 
whether  the  Interstate  Commerce  Commission,  or  any  other 
governmental  agency,  is  in  a  position  to  control  effectively  and 
safely  the  issue  of  railway  securities.  But  the  strictest  scrutiny 
of  all  financial  transactions  of  the  larger  interstate  carriers  should 
be  maintained  and  no  hesitation  felt  in  holding  a  pubUc  inquiry 
where  the  situation  seems  to  call  for  it.  However,  as  between 
federal  and  state  control  of  securities,  there  need  be  little  hesita- 
tion in  preferring  the  former. 

It  is  but  proper  to  say  that  the  opinion  of  the  commission,  as 
expressed  in  several  places,  but  most  fully  in  its  report  upon  "The 
New  England  Investigation,"  ^^  is  that  adequate  regulation  of 
interstate  railroads  is  impossible  without  national  control  of  their 
issues  of  stocks  and  bonds,  as  well  as  all  leases  or  purchases  of  one 
railroad  by  another,  all  acquisition  of  securities,  all  guarantees,  and, 
furthermore,  that  no  interstate  railroad  should  be  allowed  to  expend 
money  or  incur  liability  or  acquire  property  "not  in  the  operation 
of  its  railroad  or  in  the  legitimate  improvement,  extension  or  de- 
velopment of  that  railroad."  Such  an  attitude  is  a  very  natural 
reaction  after  the  revelations  of  its  inquiries,  and  Congress  is  not 
likely  to  need  much  inducement  to  approve  of  it.^® 

^  27  Interstate  Commerce  Commission  Reports,  p.  616. 

"  The  Clayton  Act  of  October,  1914,  specifically  forbids  corporations  from 
acquiring  the  whole  or  any  part  of  the  stock  or  share  capital  of  another  corpora- 
tion where  the  effect  may  be  substantially  to  lessen  competition,  to  restrain  com- 
merce, or  to  tend  to  create  a  monopoly.     It  also  forbids  any  interstate  common 

I  carrier,  after  two  years  from  the  date  of  the  enactment,  to  deal  in  securities  or 

supphes,  etc.,  or  to  enter  into  construction  or  maintenance  contracts,  more  than 

1  fifty  thousand  dollars  in  amount,  with  any  other  organization  when  the  former 

has  any  director  or  responsible  official  who  is  at  the  same  time  an  officer  of  or  has 

*  a  substantial  interest  in  the  latter,  unless  the  dealings,  contracts,  etc.,  are  based 

upon  the  most  favorable  competitive  bids. 


3  0112  062003824 


